Getting Left Behind – Hard For Industrials To Keep Pace With This Market
Early in the year we commented on the relative high value of most of the Industrials and Materials sectors and suggested that it would be hard for the group to outperform a rising market. The market has been rising quite quickly – the S&P 500 is up 14% year to date – and the Industrials and Materials group has lagged. We would expect this lag to continue given that we see no signs of a quick recovery in the global economy and given the importance of consumption growth to these sectors. Moreover, on market down days, these groups go down too because there is an instinct to sell the higher beta names first.
Only two subsectors are staying ahead of the market this year – Transports and Packaging. Transports was expensive to start with, so what we see is investors continuing to favor the consolidation and market structure story here – pushing many stocks to new highs. The Packaging story is more of a value play, with stocks that looked cheap reacting to more positive expectations. The Packaging sector has also seen significant consolidation, but these moves are quite recent and we have yet to see any return on capital improvement at the sector level, of the type that has propelled the Transports sector. Both of these groups are consumers of energy – fuel and plastics/glass/aluminum – and as we see oil prices moderate this might also be a boost. See our recent research note for more analysis of what is and is not working.
We are seeing some extremes in valuation – companies with below trend returns on capital where valuations are expecting returns to fall further and companies with above trend returns on capital, pricing in a further gain. The most extreme examples are summarized in the exhibit.